The Most Surprising Dividend Play of 2010

Few would have expected commercial REITs to thrive, but they have.

If you asked most investors where to find a source of strength in the currently sputtering economy, the last thing you would have expected to hear is the commercial real estate sector. But commercial real estate investment trusts (REITs) have not only survived the carnage in real estate over the past several years. They've started to recover -- and they're rewarding the investors who stayed the course with them through the downturn with higher dividends.

Forget about the next shoeNot so long ago, commercial real estate looked like it might be the next problem area for the economy at large. Anecdotal experience certainly supported that thesis; if your area's anything like mine, you probably still see a number of vacancies at strip malls, shopping centers, and office buildings. Shares of commercial REITs got smacked during the financial crisis, and the credit crunch certainly put big pressure on real-estate-related companies to batten down the hatches and make the best of a tough environment.

Fast-forward to now, though, and it's becoming increasingly evident that some companies have done exactly that. While General Growth Properties(NYSE: GGP) needed a bankruptcy proceeding to get itself out of trouble, a number of companies have shown signs of strength without resorting to bankruptcy.

Specifically, Simon Property Group(NYSE: SPG), Kimco Realty(NYSE: KIM), and Nationwide Health Properties(NYSE: NHP) have all raised their dividend payouts in the past month. Because these REITs are required to distribute at least 90% of their profits in the form of dividends, these increases suggest that profitability is starting to rise. Moreover, it also shows that the companies feel more comfortable letting cash go back to shareholders.

Show me the moneyThat's a far cry from what happened during the depths of the financial crisis. Back then, many commercial REITs, including Vornado Realty(NYSE: VNO), resorted to paying dividends in stock rather than cash. By doing so, these REITs met the statutory requirements of paying sufficient dividends to maintain their tax-favored status, but shareholders weren't always happy receiving extra stock instead of cold hard cash.

But industry experts see things getting better for commercial real estate. Fundamentals are improving, as companies make decisions about how to deal with their available space. Kimco CEO David Kelly, for instance, told the Wall Street Journal that the mall REIT is signing leases with national retailers to fill space at strip mall locations. Although conditions haven't improved to where they were at the top of the market in 2005 and 2006, there are signs that even with REITs being somewhat conservative about restoring their dividends to higher levels, the worst may well be over in many parts of the sector.

Not all REITs are created equalThat's not to say that every part of the REIT industry has seen the same level of recovery. According to the WSJ, health-care REITs and large landlord companies were most likely to increase dividends, while those in the hotel industry have been slow to raise their payouts.

Even with the turmoil among REITs, they remain a source of extra yield for investors. While S&P stocks yield less than 2% on average, the average REIT yield ran at about twice that level. A 4% yield may not seem like much, especially compared with what REITs paid a decade ago. But in an environment where 10-year Treasuries earn less than 3%, yields of 4% are nothing to sneeze at -- and many investors are grabbing them by the horns.

REITs provide a good example of why relying on common sense to assess an industry can lead you to make incorrect conclusions. Even if you see empty office buildings and shopping centers every day, the companies that own and operate those properties are still making the smart decisions that are boosting their profits and dividends -- and may well keep doing so in the months and years to come.

Editor's note: A previous version of this article incorrectly included Hospitality Properties Trust and RAIT Financial among REITs paying stock dividends instead of cash. The Fool regrets the error.

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Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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